Tuesday, October 22, 2013

Bitcoin After Silk Road: Addendum

In my haste to get this blog up and running, I made a pretty glaring omission to my earlier blog post about the shut down of the Silk Road. My post noted that contrary to my expectations, the trade price of Bitcoin only briefly dipped after the shut down of the Silk Road, and rallied very strongly shortly after. I mentioned two reasons for this:

1. The average Bitcoin investor has matured compared to previous booms and busts, lessening the severity of panic sell-offs.2. Alternatives to the Silk Road are emerging that may absorb the black market demand, preserving the transactional value of Bitcoin.

I still think these factors played a role in Bitcoin's stability throughout the post-Road period, but I forgot to mention the most obvious reason: Bitcoin users have enough faith in its legitimate uses that they're not worried about the shutdown of a shady website. (There are two other major events that occurred during this time period: The US almost defaulting on it's debt, and promotion of Bitcoin in China, I will discuss these further down)

The chart above shows what the price of Bitcoin looked like since the Silk Road shutdown. The initial downward kink is about when the news started to spread about the site's shutdown. As you can see, Bitcoin has rallied incredibly since then. (Note that the prices are for campbx.com, a smaller exchange where prices tend to be a bit lower. Today on bigger exchanges prices are averaging around $199 per coin). My interpretation of this meteoric rally and then some is that in the eyes of many Bitcoin users,the Silk Road shutdown is good for the currency.

One reason for this is that at least for now, the regulatory heat is off Bitcoin. It will heat up again, of that I'm sure, but the impetus to go after Bitcoin has definitely eroded at least a little bit, now that the major market that facilitated hundreds of millions worth of illegal transactions is gone. Most politicians who voiced concern over Bitcoin (Schumer comes to mind) did so specifically because of its black market applications. As I noted in my other post, alternative black markets will spring up and reignite the regulatory discussions, but at least for now we have a brief respite from panic-cries of the uninformed.

Now, the appeal of Bitcoin for illegal activity is fairly obvious. Bitcoin allows a savvy enough user to basically send money anywhere in the world within minutes anonymously. While every Bitcoin transaction is recorded in a ledger called the blockchain, it's fairly difficult to associate ownership of an address by a human being.

So you may be wondering what the appeal of Bitcoin is for the typical, law-abiding citizens. I noted in my Google Plus post on April 4th that BitPay, an independent Bitcoin payment processorhad eclipsed The Silk Road in terms of dollars worth of Bitcoin processed for the month of March 2013. BitPay is a completely above-ground registered business, that at least claims to only deal with other legitimate businesses.

This meant that even as far back as March, Bitcoin was beginning to shed its (in my opinion erroneous) association with illegal activity. BitPay's solutions allowed merchants, even those who didn't really understand Bitcoin, to accept Bitcoin for payments, and immediately receive cash from BitPay. For their service, BitPay charged much lower transaction fees than just about any credit-card company in existence.

And BitPay aren't the only option for merchants looking to take advantage of the emerging Bitcoin market. Coinbase offers similar solutions to those of Bitpay. Popular gift-card site Gyft allows users to purchase giftcards using Bitcoin for thousands of different online and brick-and-mortar stores (check them out, there's a good chance you could pay for your groceries/clothes in Bitcoin if you wanted to).

This addition of NPR's Planet Money describes why the simple act of "sending money" electronically is so slow. Basically, the payment processing systems we have in place right now were implemented on an ad-hoc basis, we made slow improvements from the act of "mailing paper checks back and forth" as technology allowed. Unfortunately, this system does a poor job of taking advantage of the conveniences of the internet, with weird quirks like the fact that these automated computers that process payments don't work on weekends. And further, banks have almost no incentive to improve their systems because they earn huge commissions on wire transfers.

Bitcoin on the other hand was designed to scale with technological increases. The distributed network of "miners" who process transactions runs 24/7, and because miners constantly compete to earn the Bitcoin that are created with each block, the system won't be thrown off by changes in technology.

For a transaction to be "confirmed", it generally takes around an hour. However, users can pay a fee to miners, making their transaction look more attractive to process, which typically will get it confirmed even quicker. Keep in mind, this network is global, these times apply to sending money anywhere in the world. Right now, an international transfer using Bitcoin would probably incur transaction fees on both ends ($ -> BTC -> Yuan, for instance) for converting currency. But as the number of merchants that accept Bitcoin increases, so too does the prospect for a world where the recipient of an international Bitcoin transaction can easily spend the Bitcoin she received without having to worry about converting it.

Credit card companies reap huge commissions off the fact merchants are dependent on credit cards to provide a cheap means for consumers to send money electronically. I recently purchased some Eucalyptus Soap from Wholly Hemp using Bitcoin. I was given a 10% discount for using Bitcoin, and the transaction processed within a minute.

The other benefit to the law-abiding Bitcoin user ties into two events that occurred since the Silk Road shutdown that I haven't yet discussed. First, the brinksmanship in the US congress over legislation to raise the debt ceiling (and allow the US government to pay its bills) undermined confidence in both the US dollar and US government bonds. Don't get me wrong, the dollar is the world's reserve currency and that is not going to change any time soon. Likewise, US government bonds are one of the most stable financial assets on the planet, and are often used as hedges by large and small financial institutions alike. But the reverberations of fear from this fiasco won't quickly subside, particularly since we may face the exact same thing on February 7 when the debt ceiling is reinstated. This episode demonstrated a major problem with politicized currency. And when uncertainty over one currency increases, demand for viable alternatives increases. I believe that this time around, people saw Bitcoin as one of those viable alternatives.

Additionally, Baidu, often dubbed "The Google of China" announced shortly after SR's demise that they would be accepting payments in Bitcoin. Certainly at least some of the observed increase in demand for Bitcoin is due to this, which speaks to both to Bitcoin's appeal for established corporations and its appeal in emerging markets. Afterall, transactional demand for Bitcoin accounts for at least some of its value, and this development increases the transactional use of Bitcoin. But to delve a bit deeper, I think the timing is interesting. It's possible that the Silk Road shutdown and Baidu's announcement only lined up by coincidence, but I think there's a very real chance that the two were related. It makes sense for a large company to be apprehensive about becoming associated with a "drug currency", so I think it's possible that Baidu waited until the Silk Road met it's end, so that they could make their announcement at a time when we people were beginning to look at Bitcoin for what it not for how it had been used, but how it could be used.
As with previous Bitcoin price booms, it is near impossible to divorce the effect on the price due to the factors above, from the effect on the price of investors reacting to the factors above. I think it's highly likely that prices are inflated above a middle-term pseudo-equilibrium (by which I mean around 10% variation in either direction, for a couple months), and we'll probably see a downward correction soon. But unlike previous corrections, I think it'll be a modest one, because in my opinion this whole episode with the Silk Road shutdown has served to strengthen faith and spark further enthusiasm over the long term viability of Bitcoin in legitimate markets.

1 comment:

New paper detailing a way to control the bitcoin market with only a fourth of the mining pools. I've only gotten halfway through the paper so far, so I'm not 100% sure about the theory. http://arxiv.org/pdf/1311.0243v1.pdf